Sunday Morning Coffee

Long time contributor to this site T, has his own blog and the other day he put up a post about permanent portfolios that included his ideas on how to construct one. The starting point for this concept came from Harry Browne and called for equal portions allocated to equities, long term bonds, cash and gold. This mix should mean the portfolio always has at least one thing doing well. There is also an elegant simplicity in having one fund each for stocks and bonds and since the idea was first put forth there are now funds that own physical gold.

The idea that three funds and some cash could solve all portfolio issues for all times has intellectual appeal. I believe the idea was first put forth by Browne in the late 1970s or early 1980s (anyone, feel free to correct me). Any stats I've ever seen on results have been very good but I think there is a watch out embedded in there with long term bonds. As noted the other day Rob Arnott said that bonds have averaged 10.18% annualized over the last 30 years which is a great result and contributed to the Permanent Portfolio's success but as I spelled out the other day that 10.18% annualized cannot be repeated (unless rates go back to 15% first).

In it's purest form a Permanent Portfolio could consist of the iShares S&P 1500 Index Fund (ISI) which owns the large cap 500, mid cap 400 and small cap 600 for equities, the iShares Barclays 20+ Year Treasury Bond Fund (TLT), the SPDR Gold Trust (GLD) and some cash. GLD is a client holding. It would probably make sense to pick a point where the mix should be rebalanced back to equal portions. There would be no single best way to rebalance just whatever made sense to the account holder like maybe when something grew to 30 or 35% or shrunk below 20%.

If you think the comments about about long bonds hold any water what would be a suitable replacement given current events? Big picture, there are a couple different ways to go in the realm of relatively low octane and simplicity; one would be some sort of short dated exposure that avoids interest rate risk (this could be a fund or individual issues) or some sort of foreign exposure with either close to normal (as we think of them) yields or some other appealing attribute. Many of our clients own sovereign debt from Australia that only goes out a couple of years and yields close to 4%. We also own Norwegian debt that yields quite a bit less but I believe Norway is on incredibly firm economic ground.

As for equities, what should this exposure be for people who do not live in the US? Should someone in Finland own some sort of total market Finland ETF (traded locally)? Should they own some sort of all-world fund? For that matter should a US based investor own an all world fund instead of something like ISI? To be clear, ISI is just an example there are a lot of total market funds out there.

I would point out that while the original concept was single-fund domestic exposure, there is nothing that says the equity portion can't be a properly diversified portfolio with many holdings that is actively managed. A person's equity exposure, as prescribed by Browne, could easily be $200,000-$300,000. Is one fund really the best way to go with that amount of money? T lays out some very specific ideas about how to structure the portfolio and tweaks some of the percentages--his ideas are very worth reading. If a fund like ISI is true to the original idea, then what is being advocated if not buying a country fund?

So are there any countries that are more compelling than the US for the next whatever time period you care about? Obviously I think there are many countries that will have turned out to be better holds over the next ten years. Would you be willing to put 100% of your equity exposure into one country fund? I certainly would not. What about two country funds, or three? For investors willing and able to put the time in there is some number that is comfortable.

As the ETF industry has evolved buying individual countries has become much easier to do and there is even differentiation with countries. For example if the one country you were going to buy was South Korea (this is a country we do not own which is why I chose the example) you could have some sort of split between large cap and small cap with the iShares MSCI South Korea (EWY) and the IndexIQ South Korea Small Cap ETF (SKOR). In two country mix I would think picking countries with very little in common would be the way to go, for example Chile and Switzerland each have ETFs and these countries would seem to have very little in common other than being relatively healthy. A few clients own the Chile ETF. Obviously a mix of small cap fund from one country and large cap fund from another could also work.

Hopefully it is obvious that any country selected, no matter how many countries, requires monitoring and maybe the occasional decision. Chile is absolutely one of my favorite destinations but if something changes it would be a sell. Yesterday's post about Iceland was about just that; selling a country where the story changed. The possibilities are almost endless.

One final point is that the Permanent Portfolio is about two things; one is asset allocation and the other is passive investing. An investor can choose this allocation and still have wide diversification with the stock and bond portions. I think the utility here is more in seeking to improve how you do things as opposed to switching to someone else's idea.

I've not said much about the NCAA Tournament but it has been one of the best I can remember. It is very fun to see a final four not dominated by the BCS conferences. Butler's accomplishment of making it to the final game two years in a row is truly astounding for many reasons. Also I am thrilled about baseball being back

The pictures are from the Seattle trip.